Endogenous Structural Breaks and the Stability of the Money Demand Function in Saudi Arabia

Waheed Abdulrahman Banafea

Abstract

In this study, an endogenous investigation of the long run relationship between the demand for money, narrow definition of money (M1), and its determinants in Saudi Arabia was conducted. A structural break date was estimated by applying the Andrews (1993) and Andrews and Ploberger (1994) methods. These tests illustrated that there is evidence of a structural break for all of the variables, namely money demand, real income and nominal short-term interest rates when they are considered together. The results of the Hansen stability test support the idea that the instability of money demand could be related to the structural breaks. Since there is evidence of a structural break, the Gregory and Hansen procedure was used to test for the cointegrating equation of money demand. This test allows for a one time structural break in the relationship among the money demand variable, real income and nominal short-term interest rates. The results of this test affirm stable money demand in Saudi Arabia. The monetary aggregate in Saudi Arabia seems to be an appropriate indicator in the formulation of monetary policy.

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